A company may raise
funds for different purposes depending on the time periods ranging from very
short to fairly long duration. The total amount of financial needs of a company
depends on the
nature and size of the business. The scope of raising funds
depends on the sources from which funds may be available. The business forms
of sole proprietor and partnership have limited opportunities for raising
funds. They can finance their business by the following means :-
- Investment of own savings
- Raising loans from friends
and relatives
- Arranging advances from
commercial banks
- Borrowing from finance
companies
Companies can Raise Finance by a Number of Methods. To Raise
Long-Term and Medium-Term Capital, they have the following options:-
Issue of Shares-
It is the most important method. The liability of shareholders
is limited to the face value of shares, and they are also easily
transferable. A private company cannot invite the general public to subscribe
for its share capital and its shares are also not freely transferable. But
for public limited companies there are no such restrictions. There are two
types of shares :-
- Equity shares :- the rate of dividend on these shares depends
on the profits available and the discretion of directors. Hence, there
is no fixed burden on the company. Each share carries one vote.
- Preference shares :- dividend is payable on these shares at a
fixed rate and is payable only if there are profits. Hence, there is no
compulsory burden on the company's finances. Such shares do not give
voting rights.
Issue of Debentures-
Companies generally have powers to borrow and raise loans by
issuing debentures. The rate of interest payable on debentures is fixed at the
time of issue and are recovered by a charge on the property or assets of the
company, which provide the necessary security for payment. The company is
liable to pay interest even if there are no profits. Debentures are mostly
issued to finance the long-term requirements of business and do not carry any
voting rights.
Loans from Financial Institutions-
Long-term and medium-term loans can be secured by companies from
financial institutions like the Industrial Finance Corporation of India,State
level Industrial Development Corporations, etc. These financial institutions
grant loans for a maximum period of 25 years against approved schemes or
projects. Loans agreed to be sanctioned must be covered by securities by way
of mortgage of the company's property or assignment of stocks, shares, gold,
etc.
Loans from Commercial Banks-
Medium-term loans can be raised by companies from commercial
banks against the security of properties and assets. Funds required for
modernisation and renovation of assets can be borrowed from banks. This
method of financing does not require any legal formality except that of
creating a mortgage on the assets.
Public Deposits-
Companies often raise funds by inviting their shareholders,
employees and the general public to deposit their savings with the company.
The Companies Act permits such deposits to be received for a period up to 3
years at a time. Public deposits can be raised by companies to meet their
medium-term as well as short-term financial needs. The increasing popularity
of public deposits is due to :-
- The rate of interest the
companies have to pay on them is lower than the interest on bank loans.
- These are easier methods of
mobilising funds than banks, especially during periods of credit
squeeze.
- They are unsecured.
- Unlike commercial banks, the
company does not need to satisfy credit-worthiness for securing loans.
Reinvestment of Profits
Profitable companies do not generally distribute the whole
amount of profits as dividend but, transfer certain proportion to reserves.
This may be regarded as reinvestment of profits or ploughing back of profits.
As these retained profits actually belong to the shareholders of the company,
these are treated as a part of ownership capital. Retention of profits is a
sort of self financing of business. The reserves built up over the years by
ploughing back of profits may be utilised by the company for the following
purposes :-
- Expansion of the undertaking
- Replacement of obsolete
assets and modernisation.
- Meeting permanent or special
working capital requirement.
- Redemption of old debts.
The benefits of this source of finance to the company are :-
- It reduces the dependence on
external sources of finance.
- It increases the credit
worthiness of the company.
- It enables the company to
withstand difficult situations.
- It enables the company to
adopt a stable dividend policy.
To Finance Short-Term Capital, Companies can use the following
Methods :-
Trade Credit
Companies buy raw materials, components, stores and spare parts
on credit from different suppliers. Generally suppliers grant credit for a
period of 3 to 6 months, and thus provide short-term finance to the company.
Availability of this type of finance is connected with the volume of
business. When the production and sale of goods increase, there is automatic
increase in the volume of purchases, and more of trade credit is available.
Factoring
The amounts due to a company from customers, on account of
credit sale generally remains outstanding during the period of credit allowed
i.e. till the dues are collected from the debtors. The book debts may be
assigned to a bank and cash realised in advance from the bank. Thus, the
responsibility of collecting the debtors' balance is taken over by the bank
on payment of specified charges by the company. This method of raising
short-term capital is known as factoring. The bank charges payable for the
purpose is treated as the cost of raising funds.
Discounting Bills of Exchange
This method is widely used by companies for raising short-term
finance. When the goods are sold on credit, bills of exchange are generally
drawn for acceptance by the buyers of goods. Instead of holding the bills
till the date of maturity, companies can discount them with commercial banks
on payment of a charge known as bank discount. The rate of discount to be
charged by banks is prescribed by the Reserve Bank of India from time to
time. The amount of discount is deducted from the value of bills at the time
of discounting. The cost of raising finance by this method is the discount
charged by the bank.
Bank Overdraft and Cash Credit
It is a common method adopted by companies for meeting
short-term financial requirements. Cash credit refers to an arrangement
whereby the commercial bank allows money to be drawn as advances from time to
time within a specified limit. This facility is granted against the security
of goods in stock, or promissory notes bearing a second signature, or other
marketable instruments like Government bonds. Overdraft is a temporary
arrangement with the bank which permits the company to overdraw from its
current deposit account with the bank up to a certain limit. The overdraft
facility is also granted against securities. The rate of interest charged on
cash credit and overdraft is relatively much higher than the rate of interest
on bank deposits
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